Lawsuit Could Undo Sale That Created New GM, Company Says

Tiffany Kary

August 7, 2012, 5:17 PM EDT

The new General Motors Co. could be undone by a lawsuit that pits general creditors against hedge funds including Elliott Management Corp. and Fortress Investment Group LLC over $3 billion, the car company said in a lawsuit that went to trial today.

A trust for creditors of the old, bankrupt part of the auto-maker now known as Motors Liquidation Co. sued the hedge funds in Manhattan bankruptcy court in March, alleging that while GM was preparing its bankruptcy filing on June 1, 2009, four hedge funds, which held notes in a Canadian unit of GM, “saw an eleventh-hour opportunity for profit and pounced.”

The trust seeks to have a $2.67 billion claim and a $367 million payment negotiated for holders of notes in GM’s Nova Scotia unit disallowed or reduced, saying the hedge funds seek more than three times what General Motors actually owed them. The amounts, agreed to as part of a settlement known as the “Lock-Up Agreement” resolved a dispute the hedge funds had brought over an intercompany claim GM’s Nova Scotia Finance unit had against GM Canada.

General Motors, the currently operating auto-maker which split off from the bankrupt unit through a purchase of its assets July 10, said the trust’s objections “threaten to disturb” the sale that saved the U.S. auto-maker, allowing it to prosper.

The trust, known as Motors Liquidation Co.’s GUC Trust, which represents creditors’ rights to recover stock and warrants in the case, recently traded at $13.94. One trust unit is equivalent to $1,000 worth of general unsecured claims, and units in the trust became transferrable on June 12, according to a Web site for the trust.

Preserve Order

“New GM intends to participate in the trial of the claims objection to the extent required to protect and preserve the sale order,” lawyers for the company wrote. The company said that if the lawsuit undoes the lock-up agreement, it could spawn new lawsuits, and create a “chaotic situation” for GM Canada, as well as all creditors, who are being repaid through warrants to buy stock in the new company.

The trial before U.S. Bankruptcy Judge Robert Gerber in Manhattan will partly revolve around whether the lock-up agreement was finalized before GM’s 7:57 am petition.

The notes at issue, 8.375 percent notes due 2015 and 8.875 percent notes due 2023, recently traded at 43.9 cents and 43.8 cents on the dollar, respectively, according to Trace, the bond price reporting system of the Financial Regulatory Authority.

Maximum Advantage

The trust says four hedge funds, pushing for maximum advantage as they negotiated through dawn in the offices of Weil Gotshal & Manges LLP, an adviser to GM’s Canadian subsidiaries, didn’t finish the agreement until 9:21 am on June 1. Furthermore, a precondition of the agreement -- the consent of two-thirds of the note-holders --- wasn’t obtained until June 25, more than three weeks later, the trust said it will show at trial.

The two other funds, Appaloosa Management LP and Aurelius Capital Management LP have sold their notes and no longer have a claim in the case. Morgan Stanley & Co International Plc, a unit of Morgan Stanley, has joined Fortress and Elliott in court papers arguing against the trust’s lawsuit.

Since the agreement wasn’t completed until after General Motors actually filed for bankruptcy protection, it requires bankruptcy court approval, which was never obtained, the trust said, adding that the hedge funds misrepresented the agreement as ending before the bankruptcy in order to evade court scrutiny.

Pure Fabrication

In a pretrial brief, the noteholders said the allegations “have always been a pure fabrication” and that they negotiated at General Motors’ request for the benefit of all holders of notes in the Nova Scotia unit to satisfy an intercompany loan that would have also bankrupted its Canadian unit. The agreement satisfied the loan “at a substantial discount” and the settlement was approved by the U.S. and Canadian governments in the early morning of June 1, the hedge funds said.

The trial began today with no opening arguments. A trustee for the Canadian unit, Peter Wedlake, testified before Gerber that he had the authority to examine aspects of General Motors’ Nova Scotia Finance Co., but did not.

The trust has said the hedge funds “hand-picked” Wedlake, who they had worked with on investment schemes before, to be a trustee for the Nova Scotia notes and had already worked with him on a lawsuit against the Nova Scotia unit and some of its officers and directors.

Consent Fee

After getting the $367 million “consent” fee, the noteholders waited until just over 90 days before petitioning for the Nova Scotia unit’s bankruptcy, Wedlake testified. Under bankruptcy law, sums transferred out of an estate before 90 days prior to a bankruptcy filing can more easily be clawed back for sharing among all creditors.

General Motors said the agreement was important for it because it resolved the dispute over intercompany loans and allowed the U.S. and Canadian governments to buy GM Canada without creating a separate bankruptcy for it. Without the ability to do that, the company would have immediately liquidated, giving creditors of the old GM nothing, lawyers for the auto-maker said in court papers.

“The Governments (especially the governments of Canada and Ontario) wanted New GM to acquire GM Canada as part of the 363 sale without having to file GM Canada,” lawyers for GM wrote in court papers. In order to do so, GM Canada needed to “compromise” the intercompany loans GM Canada owed to the Nova Scotia unit.

If any changes were made to the documents after the bankruptcy petition was filed it was to “clean up a scrivener’s error,” GM said in court papers.

Forgiven Claim

Paulson & Co. funds, also investors in the two tranches of Nova Scotia notes, said in court papers that as part of the settlement, the noteholders “gave up a lot in return” including the intercompany claim, worth $1.334 billion, which was forgiven under the agreement.

Before the lock-up agreement, the face amount of the claims held by the notes was less than $1 billion, the trust has said in court papers.

Gerber’s wind-down order in 2011 sealed the government-backed separation of the automaker’s liabilities from its most profitable operations, which took place in 2009. Motors Liquidation Co.’s plan repays general unsecured creditors through a trust. The trust is set up to pay general unsecured creditors through receive stock and two series of warrants, one with an exercise price of $10 a share that expires in July 2016, and another with an exercise price of $18.33 a share that expires July 2019, according to court papers.

The main bankruptcy case is In re Motors Liquidation Co., 09-50026, U.S. Bankruptcy Court, Southern District of New York (Manhattan). The adversary case is Motors Liquidation Company GUC Trust v Appaloosa Investment Limited Partnership I, 12-09802, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

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